To be
honest, we’re not sure at this point which ultimately will be more painful to watch: falling
down the well eight years back or posturing Shakespeare every month or so - to
hike or to not hike us out. Perhaps, ‘tis
nobler in the mind to suffer… than take arms against a sea of troubles? Suffer we have, although the truth has always been that the markets return from
the trough would likely be a painfully long process, despite conventional
wisdom that looked towards more contemporary tightening cycles for example. In
this regard, score one for Monday's "Good Cop Williams", who appears to approach
the situation in better context and with more realistic expectations. Lower for longer indeed, even if Thursday's "Bad Cop Williams" bucket slowly rises – if only to take the
slack out of the line as the water level gradually climbs.

With
Yellen’s speech on deck next Friday and with the September Fed meeting just a
few weeks thereafter, markets are headed towards a rather charged environment when
it comes to policy expectations – one that could easily disappoint or further
confuse. Speaking of which, we’re reminded of the dog days of 2012, when then
Chairman Bernanke in his Jackson Hole speech described the fledgling state of
the US labor market and the apparent lack of efficacy of current monetary
policy in addressing said concerns.

"The stagnation of
the labor market in particular is a grave concern not only because of the
enormous suffering and waste of human talent it entails, but also because
persistently high levels of unemployment will wreak structural damage on our
economy that could last for many years." - Monetary Policy since the Onset of the Crisis 8/31/12

In
hindsight, Bernanke’s speech built out the case for further easing that
September and what eventually became a massive open-ended QE3 program later that year. Following Jackson Hole, precious metals and commodities enjoyed the
greatest bid in the markets through September, as participants continued to see
a causal relationship between stimulus and inflation. By their calculus, you
only needed to look back at the hint of QE2 in Bernanke’s Jackson Hole speech
in 2010 and the subsequent performance of assets closely tied to inflation to
see the connection.

Back
then, although we had anticipated the rally in precious metals would
materialize that summer (see Here), we approached the performance parallels with
previous QE with significant skepticism (see Here) to even an intermediate-term
outlook. From our point of view, the markets were simply in a different part of
the cycle where the impetus of stimulus was significantly less benevolent towards
commodities and assets sensitive to inflation.

- The
commodity markets, that have rallied so fervently this summer in
anticipation of another bolus by the Fed, the ECB and the PBOC - will need to
overcome the notion of "pushing on a string", that was not nearly as
applicable in 2010 - as it is today. It is my belief, based on my comparative
work with the US dollar, the Australian dollar and the CRB, that the commodity rally ignited this
summer will fail - and fail as prominently as the equity markets faired to the
aggressive monetary policy regimes enacted by the Fed at the end of
2007. Back then, market psychology quickly pivoted from - "Don't
fight the fed!" to "the Fed is pushing on a string!" -
almost overnight. – A Lucid Confusion 9/17/12

What we
find particularly interesting today when it comes to cycles and the intersection
of policy, expectations and the markets – is the inverse symmetry of where we currently
reside relative to that period and with respect to inflation. This perspective is also framed by the chart of the banks and the gold miners we’ve followed this year,
that depicts a mirrored performance pattern primarily driven by trends in the
dollar, inflation and hence – the direction of real yields (see recently Here).

Long
story short, we believe real yields will have further to fall, which consequently should
support the performance trends of precious metals and commodities and continue to pressure
assets such as the financials. When all’s said and done, the reality is the potential
reach of inflation today is likely greater than what the Fed or the market is ultimately willing to stomach in raising rates. In the end, we expect "Good Cop Williams" and his San Francisco Fed's approach towards policy to win out, even if
the bucket rises by another 25 basis points this year and the drift
towards consensus continues to be more reactionary and forced by the markets – as it
has been over the past two years.

How
Yellen’s speech is received by the markets over the short-term is anyone’s guess. But following
the behavioral cues from the miners in 2012 that has closely mimicked the
seasonal performance structure of the financials today – the banks and equity
markets may have a bit further room to run into September before the rally exhausts. Notice the trend line break in the miners going into that fall and the subsequent failure into Q4. The KBW Bank Index currently sits above a similar trend line break. Extrapolating the intermarket tea leaves a bit further, this would likely
coincide with an extension of the nascent rally in yields as well as a minor
retracement rally in the dollar. Moreover, these conditions could present
another short-term high for precious metals over the next week or so followed
by what we suspect would be the final major retracement decline for precious
metals this year.

When it
comes to the dollar and oil, oil followed the dollar’s pivot (see Here) higher from July as it has over the past year and is now working on the shoulder of the broad reversal we suspect will eventually resolve with fresh 52-week highs later this year.

As for the dollar itself, although it remains bracketed by the range of previous major tightening regimes, ultimately, we believe it will continue along a weaker performance pattern, such as the profiles from 1994/1995 and 1986/1987. While into September we expect another minor retracement rally to develop, conditions needed to sustain the move should prove ephemeral and we continue to look for another leg down into Q4.

N o rest for the weary – or the wicked, as the New Year gets quickly to the point with a few key economic data plots this week. Coming th...

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Disclaimer

This is not investment advice. Erik Swarts is not a registered investment advisor. Under no circumstances should any content from this website be used or interpreted as a recommendation for any investment or trading approach to the markets. Trading and investing can be hazardous to your wealth. Any investment decisions must in all cases be made by the reader or by his or her registered investment advisor. This is strictly for educational purposes only.